Volume 3 – Number 6

Oil is Not in Short Supply

“Oil is not in short supply” is the conclusion of a recent report authored by Leonardo Maugeri of the Harvard Kennedy School. What’s even more surprising is that Maugeri thinks “oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption”, which could lead to a steep drop in oil prices in the near future. Despite the contrarian view, Maugeri’s conclusions are based on what seems to be carefully reasoned analysis: Maugeri took a bottom-up approach and analyzed a majority of the individual oil exploration and development projects around the world, something which has not been done before.

In addition to the excellent overviews of the history of estimating oil supplies and the production revolution in U.S. shale and tight oil formations, there were numerous, fascinating data points. However, the report is long at over 70 pages. Thus, we present to you our summary of what we felt was most interesting.

First and most important is the U.S. has the ability to become the second largest producer of oil in the world (after Saudi Arabia) by 2020. This is primarily a result of price and technology aligning to allow companies to extract oil from tight oil formations in North Dakota, Montana and twenty other large shale formations across the country. With oil prices above $50 to $65 per barrel and technological innovations such as hydraulic fracturing and horizontal drilling, the U.S. has a huge amount of energy resources. The only factors that can limit this potential are the political and regulatory decisions that happen above the ground.

Secondly, there still exists a huge potential for other major producing countries around the world to improve their oil recovery rates (the recovery rate is simply the percent of oil that can be extracted from the estimated oil in the field) with investments in technology and better practices. For example, the current leading producers—the Russian Federation, Iran, Venezuela, Kuwait, and others—have a 20% recovery rate compared to a 35% worldwide average and rates of 45% for countries like the U.S., Canada, Norway, and the U.K.

Iraq in particular is a stark example of how politics can hold back huge potential. Since the dawn of the 20th century, only 2,300 wells have been drilled in Iraq compared to about one million in Texas. With a chronic state of underdevelopment (Iraq’s recovery rate is roughly 15%), Iraq likely has 200 billion barrels more of reserves than currently documented.

Thirdly, the history of estimating reserves in the U.S. is a fascinating subject. For example, the Kern River Field in California is instructive in how price and technology can extend the life of a property far into the future. First discovered in 1899, analysts thought only 10 percent could be recovered from the Kern River. In 1942, it was estimated the field still held 54 million barrels, a fraction of the 278 million already recovered. Then, over the next 44 years, it produced 736 million barrels, almost 14 times greater than the 1942 estimate. The Kern River is not an isolated example—this has happened with many other geographies and will continue to happen for decades to come.

Finally, the most important conclusion in Maugeri’s summary is that although the age of “cheap oil” is probably behind us, technology will allow humanity to continue to extract vast amounts of conventional and unconventional oil. Another conclusion is the possibility there will be major overproduction in the world after 2015 which could lead to a significant decline in oil prices should demand not grow at a rate of at least 1.6% yearly.

If you are interested in reading the full report, you can download it by clicking here.

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  • Being a value investor usually means standing apart from the crowd, challenging conventional wisdom, and opposing the prevailing investment winds. It can be a lonely undertaking.

    — Seth Klarman